Crypto’s rapid expansion leaves regulators rushing to keep pace

With the val­ue of the glob­al cryp­tocur­ren­cy mar­ket north of $3tn (£1.09tn) and main­stream cryp­to adop­tion con­tin­u­ing to accel­er­ate, glob­al reg­u­la­tors are rac­ing to keep up.

In March, Pres­i­dent Joe Biden signed an exec­u­tive order that tasks the entire US gov­ern­ment with form­ing a strat­e­gy to reg­u­late dig­i­tal assets, includ­ing cryp­tocur­ren­cies.

Mean­while, in Europe the EU is in the process of final­is­ing its mar­kets in cryp­to assets leg­is­la­tion, which seeks to over­see cryp­to activ­i­ties that fall out­side exist­ing reg­u­la­tions. The UK’s FCA also ear­li­er this year pro­posed tougher rules on cryp­to adver­tis­ing to stamp out false or mis­lead­ing claims.

“Those who are new to this or just pressed for time will say cryp­to is unreg­u­lat­ed – noth­ing could be fur­ther from the truth,” says Mar­co San­tori, chief legal offi­cer at Krak­en, a cryp­to exchange. 

Much of the ear­ly reg­u­la­to­ry agen­da for cryp­tocur­ren­cies and the emer­gence of blockchain tech­nol­o­gy focused on mon­ey ser­vices, though since 2017 with the boom in ini­tial coin offer­ings, that has start­ed broad­en­ing into areas such as cap­i­tal for­ma­tion, says San­tori.

“There are new, emerg­ing uses of blockchain tech­nol­o­gy that impli­cate new risks and are cre­at­ing new indus­tries – it’s those emerg­ing uses that are under reg­u­la­to­ry scruti­ny,” he says.

But giv­en the rapid pace of cryp­to adop­tion, reg­u­la­tors have strug­gled to keep pace.

“Reg­u­la­tion has lagged but as Biden’s order indi­cates, there is a grow­ing aware­ness that there needs to be a much tighter reg­u­la­to­ry frame­work around cryp­to,” says Ben Rich­mond, founder and CEO of regtech com­pa­ny Cube Glob­al.

Enforce­ment actions are also start­ing to increase. The US Secu­ri­ties and Exchange Com­mis­sion (SEC), for instance, has brought around 100 cryp­tocur­ren­cy enforce­ment actions since 2013. The agency’s new chair­man, Gary Gensler, said the SEC hopes to start reg­u­lat­ing cryp­to exchanges this year.

“Learn­ings from those actions are dri­ving reg­u­la­tor behav­iour, but that’s where it risks becom­ing frag­ment­ed because you can end up with dif­fer­ent approach­es to the same prob­lem,” says Rich­mond.

Methods for regulating cryptocurrencies

Anoth­er debate has fizzed around how to reg­u­late cryp­to – should it be bolt­ed on to exist­ing reg­u­la­tions or reg­u­lat­ed as a sep­a­rate indus­try, with its own reg­u­la­tor and laws?

Tim­o­thy Span­gler, a US-based part­ner at law firm Dechert, believes it should be the for­mer.

“I would rather spend more time under­stand­ing the tech­no­log­i­cal impacts than cre­at­ing new reg­u­la­tors, new crimes and new over­sight mech­a­nisms, and then hav­ing to debug those over years,” says Span­gler. “That could unnec­es­sar­i­ly stymie inno­va­tion.”

Oth­ers argue that the nov­el­ty of blockchain tech­nol­o­gy means it shouldn’t be shoe-horned into cur­rent reg­u­la­tions.

“Most reg­u­la­tors are using a tra­di­tion­al approach to reg­u­late cryp­to,” says William Je, CEO of Hamil­ton Invest­ment Man­age­ment. “But cryp­to is cre­at­ing new finan­cial prod­ucts that are entire­ly dif­fer­ent to any­thing that has come before.”

Some juris­dic­tions are tak­ing a more active pro-cryp­to stance to attract cryp­to busi­ness­es, such as US state Wyoming, which has passed a series of cryp­to-friend­ly blockchain laws.

“Wyoming has tak­en a descrip­tive rather than a pre­scrip­tive approach to reg­u­la­tion and is a mod­el for oth­er juris­dic­tions,” says San­tori.

One ini­tia­tive Wyoming has adopt­ed is cre­at­ing a bank­ing license that tai­lors the reg­u­la­to­ry regime to the actu­al risks of the bank. For instance, Krak­en was the first cryp­to com­pa­ny to receive a license under the state’s new bank­ing char­ter aimed at dig­i­tal asset busi­ness­es, which allows them to take deposits as opposed to make loans.

“It dials up over­sight of reserves and for­goes the reg­u­la­tions usu­al­ly be required for banks that lend,” says San­tori. 

This is the biggest hur­dle for the devel­op­ment of cryp­to, so we need more clar­i­ty

A focus on cryp­to-min­ing activ­i­ties, par­tic­u­lar­ly around ener­gy use, is also attract­ing the atten­tion of reg­u­la­tors. Chi­na has banned cryp­to min­ing, while the EU con­sid­ered ban­ning cer­tain ener­gy-inten­sive meth­ods for min­ing cryp­to but has since backed down. 

“To say that we need to reg­u­late cryp­to min­ers is to say that cryp­to min­ing pos­es a dan­ger, but we’re a long way from quan­ti­fy­ing that,” says Span­gler. “How com­fort­able are we that we accu­rate­ly know the ener­gy usage that min­ers engage in? Most of the aca­d­e­m­ic sur­veys are qual­i­fied and spec­u­la­tive.”

While reg­u­la­to­ry best prac­tice is a work-in-progress, Span­gler believes those juris­dic­tions that tread cau­tious­ly are like­ly to yield more effec­tive long-term out­comes.

“We need to move at the right pace to make good deci­sions,” he says. “We want to move for­ward based on knowl­edge. Move slow­ly and roll out things as need­ed – we don’t know where blockchain will move.”

How regulators are addressing crypto across the world

But while the US has tra­di­tion­al­ly set the stan­dard for glob­al finan­cial reg­u­la­tion, it is not a giv­en that it will shape how cryp­to reg­u­la­tion devel­ops world­wide.

“Most peo­ple would agree that crypto’s cen­tre of grav­i­ty ini­tial­ly was the US and Cana­da, but there’s no rea­son why hav­ing cre­at­ed a new tech­nol­o­gy or pro­to­col, they would also win the deploy­ment,” says Span­gler.

A lack of reg­u­la­to­ry har­mon­i­sa­tion across juris­dic­tions is also poten­tial­ly weigh­ing on the growth of the cryp­to mar­ket.

“Every coun­try has dif­fer­ent rules and reg­u­la­tions or even def­i­n­i­tions of what should be reg­u­lat­ed, so at the moment it’s not clear, which is hold­ing back insti­tu­tion­al investors from invest­ing in cryp­to,” says Je. “This is the biggest hur­dle for the devel­op­ment of cryp­to, so we need more clar­i­ty.”

Oth­ers believe that while reg­u­la­tion is nec­es­sary to safe­guard con­sumers, it could slow the pace of adop­tion.

“It’s about get­ting the bal­ance right – how do you pro­tect peo­ple but enable this world to flour­ish,” says Rich­mond. “The con­cern is that if the reg­u­la­tion comes in too hard, it will slow down the uptake.”

Wor­ries that too much reg­u­la­tion could choke inno­va­tion are like­ly to be overblown, though San­tori believes some inno­va­tion will inevitably be con­strained as reg­u­la­tors tight­en their grip.

“That’s the trade-off when we reg­u­late,” he says. “But we also cre­ate a more sta­ble and wel­com­ing envi­ron­ment, so that is the cor­rect lens to view the deci­sion of whether to reg­u­late.”

As blockchain tech­nol­o­gy con­tin­ues to thrive and new use cas­es emerge, one thing is cer­tain: the reg­u­la­to­ry back­drop is far from resolved.

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